What is the Purpose of Statement of Cash Flows?

Purpose of Statement of Cash Flows

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Purpose of Statement of Cash Flows

The Statement of Cash Flows is one of the core financial statements issued by a company, and it provides a detailed account of the cash inflows and outflows from the company during a particular period. It’s broken down into three sections: Operating Activities, Investing Activities, and Financing Activities. Here’s the primary purposes of a Statement of Cash Flows:

  • Cash Generation and Usage: The statement shows how a company generates its cash and how that cash is used. This is crucial as businesses need cash to pay their bills and invest in new opportunities.
  • Evaluate Profitability: The statement can be used to understand how much cash is generated from the company’s core operations, providing an alternative measure of profitability to net income.
  • Investment and Financing Decisions: By providing detailed information on a company’s cash flow from investing and financing activities, the statement helps stakeholders understand how a company is investing in its future and how it’s financing those investments.
  • Cash Flow Solvency: It helps stakeholders assess the ability of a company to pay dividends, make necessary capital expenditures, and repay its debts, which are all critical for the company’s solvency.
  • Reconciliation of Operating Activities: The statement reconciles the company’s income statement with changes in balance sheet accounts to show how net income was arrived at, starting from net cash provided by operating activities.

In summary, the Statement of Cash Flows provides crucial information about a company’s liquidity, solvency, and overall financial health that cannot be fully understood by looking only at the income statement and balance sheet.

Example of the Purpose of Statement of Cash Flows

Let’s consider a hypothetical company, “Tech Innovations Inc.” Here’s a simplified version of their Statement of Cash Flows for the year 2023:

Cash Flows from Operating Activities
Net income: $500,000
Adjustments for:
Depreciation and amortization: $100,000
Changes in working capital: -$50,000
Net cash provided by operating activities: $550,000

Cash Flows from Investing Activities
Purchase of property and equipment: -$200,000
Investment in research and development: -$150,000
Net cash used in investing activities: -$350,000

Cash Flows from Financing Activities
Proceeds from issuance of debt: $300,000
Payment of dividends: -$100,000
Net cash provided by financing activities: $200,000

Net increase in cash and cash equivalents: $400,000
Cash and cash equivalents at beginning of year: $200,000
Cash and cash equivalents at end of year: $600,000

Here’s what the Statement of Cash Flows tells us about Tech Innovations Inc.:

  • Cash Generation and Usage: The company generated $550,000 in cash from its operating activities and used $350,000 in its investing activities. It also raised $200,000 in financing activities. The net increase in cash and cash equivalents for the year was $400,000.
  • Evaluate Profitability: The company’s net income was $500,000, but after adjusting for non-cash expenses and changes in working capital, the actual cash generated from its operations was $550,000.
  • Investment and Financing Decisions: The company invested $350,000 in property, equipment, and research and development, showing that it’s investing in its future growth. It also raised $300,000 through debt and paid out $100,000 in dividends.
  • Cash Flow Solvency: The company has a positive net cash increase, suggesting that it is generating enough cash to pay its bills, make necessary investments, and service its debt. The company’s ability to pay a dividend also indicates a level of financial stability.

In this example, the Statement of Cash Flows provides a clear picture of how Tech Innovations Inc. is generating and using its cash, its investment and financing activities, and its overall cash flow solvency.

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